Since the adoption of the new regulatory framework for retail clients last year, a number of companies have been vocal about the changes to the industry. Some have been defending the industry, others the regulators, but ultimately, this business is about servicing clients.
As we already highlighted in the past, the profitability of retail clients and their exposure to risk has been at the core of ESMA’s message to the industry. With the advent of the new regulations well behind us, this week the CEO of Saxo Capital Markets shared some insights on the latest developments in the industry.
Leading one of the companies who have been publicly supporting ESMA’s effort his insights may not come as a surprise, but they do serve to highlight the importance of the current pivot which the industry is forced to make.
For years the interests of clients have not been the priority for many brokers and the development of gambling habits has overpowered long-term business viability. With the market starving for a solution to the age-old problem on how to help retail clients more profitable, Andrew Edwards points at the key reason for the industry to be having a problem: leverage.
The CEO of Saxo Capital Markets explained that the company has been a vocal supporter of the proposals set forth by the ESMA. The race to out market each other with higher and higher leverage had to end some day and Edwards believes that the actions on part of the regulators have been timely.
He is also highlighting passporting across Europe as one regulation which was taken advantage of by some market players. He thinks that a part of the industry operated from countries with low regulatory governance and focused on marketing to less sophisticated clients and offered them high leverage and incentives to potentially trade beyond their means.
“What is particularly interesting to observe is that, since the ruling last year, shares in all the industry’s big listed trading firms have fallen between 30 and 40 per cent, reflecting the fact that the new regulations will continue to compress the margins of firms in the sector overall,” the CEO of Saxo Capital Markets UK said.
The ongoing transformation to the business is also preventing new players to enter the market, the industry veteran thinks. “Lower profits become less attractive for those counting on business models which rely on leverage,” he elaborated.
Competing Beyond Leverage
Before the introduction of the new regulatory framework by the ESMA, leverage has become a competing point. As your fellow author of this article remembers his first steps as a retail trader in 2004, 1:100 was pretty much the maximum one could get to. Over the years, I was stunned to see companies offering as much as 1:2000.
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Firms had access to enough data to figure out that the higher the leverage, the faster a client is hemorrhaging cash into the pockets of the brokerage. Edwards highlighted that prior to the introduction of the new rules, the levels of gearing which were being offered by some brokers were disproportionate compared to the risk tolerance of an average retail client.
“In some cases, they were plain irresponsible, unethical and led to a race to the bottom in the trading industry. Parts of the margin trading industry were simply not sufficiently focused on protecting clients’ interests. It is important in this debate, however, to not to lose sight of the fact that this is a leverage problem – not a product problem,” the CEO of Saxo Capital Markets UK thinks.
Advocating responsible limits on leverage rather than outright banning of products is key to consumer protection according to Edwards. He highlights how clients can use moderate levels to make use of strategies typically reserved for high-class institutional traders.
“Trading with CFDs and FX instruments brings a number of advantages allowing traders to trade the full global macro cycle, build a diversified capital allocation and hedge their market exposure in a flexible and efficient way. Clients will often use the option to short a CFD as a hedge on a long stock portfolio or short a stock index as a hedge against general market moves on a single stock investment,” Edwards says.
Responsible Trading or “Unrecoverable Decline”
The importance of promoting responsible trading among clients is clearly the way forward, and firms are already working on how to strike the right balance. Edwards thinks that overall, the new regulatory environment in Europe will be positive for trading firms.
“We continue to believe that offering very high leverage, which is out of sync with underlying market conditions at any given time, is irresponsible. Looking ahead, we fully expect that the regulations imposed by ESMA will continue to impact the margins of some firms in our sector. In turn, marketing budgets will be cut as non-compliant firms fall into an unrecoverable decline,” Edwards shared.
The CEO of Saxo Capital Markets also thinks that some firms will look to sell their CFD client books which concurrently creates opportunities. For those however who rely on high leverage, incentives and miss-selling he sees a grim picture: they will either close down voluntarily, be forced to shut their doors or get acquired.
Edwards also thinks that regulators should not prevent high-quality firms with ethical and strong business to acquire client books and embark on M&A activity.
“For the industry to survive and grow over the long term, it should welcome the move away from competition on leverage and embrace competition on quality of platform, price, product, and service,” Edwards concluded.